Everybody knows the deal these days on natural gas. E&P companies like Cabot Oil & Gas (NYSE:COG) have been incredibly successful at finding and exploiting new sources of natural gas, but the U.S. energy infrastructure has not shifted as radically. Consequently, inventories are high and prices are low, which has kept a lid on many of the stocks. Although Cabot's near-term valuation wouldn't suggest that it's a compelling buy, I think a longer-term perspective suggests a different answer.

Investopedia Broker Guides: Enhance your trading with the tools from today's top online brokers.

Growth Is Definitely Not the Problem
Cabot is by no means struggling to post impressive-looking production growth numbers. For the second quarter, for instance, the company saw 40% year-on-year production growth - and that was actually disappointing due to infrastructure delays in the key Marcellus region.

Production growth is only part of the story, though. Realized prices were down 48% from last year, and that's an incredibly difficult headwind to offset. Likewise, unit production costs continue to rise (about 13% year on year), and that sent unit profits spiraling down (down 74% from last year's second quarter).

SEE: A Guide To Investing In Oil Markets

A Top-Notch Player
It's not always easy to see the quality of a commodity producer when the commodity in question is under serious pressure. Now, natural gas has rebounded strongly since the spring, buoyed in part by demand from electrical utilities, but still stands below $3 per million BTUs. At this level, it's hard for even the best companies to make real profits.

Nevertheless, Cabot has the markings of an excellent company. The company's finding and development (F&D) costs are among the lowest in the industry, as are its lifting costs. What's more, when you compare its capital productivity to other well-run names like Ultra Petroleum (NYSE:UPL), Southwestern (NYSE:SWN) and Range Resources (NYSE:RRC), Cabot looks quite good indeed, with nearly twice the productivity.

Gas Today and Gas Tomorrow
While Cabot has been exploring liquids-rich asset plays in the Anadarko (where initial Marmaton results have looked quite good) and the Eagle Ford, let's not get carried away. With over 96% of Cabot's 2011 year-end proven reserves in natural gas, this is going to be a natural gas story.

Therefore, it probably goes without saying that the future of natural gas pricing is of central importance to Cabot. Sooner or later, I think prices have to increase. With current prices making it so difficult to make money, many producers have switched over to produce as much oil as possible. At the same time, there are compelling long-term arguments for more gas-fired electricity generation in the U.S.

It's also worth considering the international arbitrage angle. Right now, liquified natural gas imports are going for about $14.50/MMBtu in Japan. That discrepancy creates a lot of incentive to build LNG terminal facilities, and that's actually happening in the U.S. right now - though not at the pace natural gas bulls may like.

SEE: Oil And Gas Industry Primer

The Bottom Line
Cabot's huge position in the Pennsylvania Marcellus, as well as other assets like Utica, Eagle Ford, Anadarko and so on, suggests a lot of potential production growth over the coming years. At the same time, the company's conservative management and cost discipline points to the probability of that being profitable production growth.

Unfortunately, today's numbers don't work out so well. Analysts are still conservative on natural gas prices in 2013 and 2014 and that is compressing EBITDA estimates - making Cabot's valuation appear not-so-compelling. And to be fair, if natural gas prices do stay below $4 or $3.50, it's hard to argue for owning this stock. Taking a longer-term view, though, and assuming that U.S. natural gas prices will close the gap with international prices, Cabot looks like a high-quality way to play a better future for natural gas.

At the time of writing, Stephen D. Simpson did not own shares in any of the companies mentioned in this article.

Related Articles
  1. Stock Analysis

    Net Neutrality: Pros and Cons

    The fight over net neutrality has become an amazing spectacle. But at its core, it's yet another skirmish in cable television's war to remain relevant.
  2. Savings

    Do Natural Gas Prices Always Follow Oil Trends?

    Prices for oil and natural gas are highly correlated. But investors should be aware of different factors affecting the prices of these commodities.
  3. Personal Finance

    A Day in the Life of an Equity Research Analyst

    What does an equity research analyst do on an everyday basis?
  4. Mutual Funds & ETFs

    ETF Analysis: PowerShares S&P 500 Downside Hedged

    Find out about the PowerShares S&P 500 Downside Hedged ETF, and learn detailed information about characteristics, suitability and recommendations of it.
  5. Mutual Funds & ETFs

    ETF Analysis: ProShares Large Cap Core Plus

    Learn information about the ProShares Large Cap Core Plus ETF, and explore detailed analysis of its characteristics, suitability and recommendations.
  6. Mutual Funds & ETFs

    ETF Analysis: iShares Core Growth Allocation

    Find out about the iShares Core Growth Allocation Fund, and learn detailed information about its characteristics, suitability and recommendations.
  7. Mutual Funds & ETFs

    ETF Analysis: iShares MSCI USA Minimum Volatility

    Learn about the iShares MSCI USA Minimum Volatility exchange-traded fund, which invests in low-volatility equities traded on the U.S. stock market.
  8. Stock Analysis

    Should You Follow Millionaires into This Sector?

    Millionaire investors—and those who follow them—should take another look at the current economic situation before making any more investment decisions.
  9. Professionals

    What to do During a Market Correction

    The market has corrected...now what? Here's what you should consider rather than panicking.
  10. Mutual Funds & ETFs

    ETF Analysis: Vanguard Mid-Cap Value

    Take an in-depth look at the Vanguard Mid-Cap Value ETF, one of the largest and most popular mid-cap funds in the U.S. equity space.
RELATED TERMS
  1. Equity

    The value of an asset less the value of all liabilities on that ...
  2. Hard-To-Sell Asset

    An asset that is extremely difficult to dispose of either due ...
  3. Sucker Yield

    When an investor has essentially risked all of his capital for ...
  4. Benchmark Crude Oil

    Benchmark crude oil is crude oil that serves as a pricing reference, ...
  5. Unconventional Oil

    A type of petroleum that is produced or obtained through techniques ...
  6. Green collar

    A worker who is employed in an industry in the environmental ...
RELATED FAQS
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

COMPANIES IN THIS ARTICLE
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!